Japanese powerbroker Ichiro Ozawa said on Tuesday he would stick to his plan to challenge Prime Minister Naoto Kan in a party election, setting up a showdown that threatens to create a policy vacuum as Japan struggles with a strong yen and a fragile economy.

The strife in the Democratic Party of Japan (DPJ) coincides with policymakers' efforts to curb a rise in the yen that is threatening the economic recovery.

A Bank of Japan decision to boost a cheap loan scheme at an emergency meeting on Monday did little to weaken the yen, still hovering near a 15-year high against the dollar hit last week.

Ozawa announced his decision after a meeting with Kan, which had followed party efforts to avoid a split in the DPJ that could well result if the two heavyweights face off in a September 14 leadership vote, the winner of which would likely become premier.

As I have said before, I have decided that although I am unworthy I would like to take part (in the race) with everyone's support, Ozawa told a news conference at party headquarters.

The Democrats swept to power for the first time just one year ago but have stumbled on economic and diplomatic fronts, struggling to craft a credible plan to end decades of stagnation and straining ties with key security ally the United States.

NO BACKDOOR DEAL?

Kan took over in June after Hatoyama abruptly resigned, his support ratings in tatters.

Japanese media had said Ozawa wanted a senior party post as well as personnel changes including the replacement of Chief Cabinet Secretary Yoshito Sengoku and DPJ Secretary-General Yukio Edano, in return for agreeing not to run in the party election.

But lawmakers close to Kan had rejected a deal, which would have prompted voter support for the party to nosedive.

Ozawa, 68, has criticised Kan for floating a possible rise in the 5 percent sales tax ahead of a July upper house election, defeat in which cost the ruling bloc its majority in the chamber, forcing the Democrats to seek opposition help to pass bills.

He also wants to stick to pledges made before last year's general election to put more cash in households' hands, while Kan has signalled the need to revise the promises given a public debt that is already twice the size of the $5 trillion economy.

Admirers have credited Ozawa with engineering the huge election win that swept the DPJ to power but many voters are put off by his image as a scandal-tainted wheeler-dealer.

Opinion polls consistently show that a vast majority of Japanese voters want Kan -- already Japan's fifth premier in three years - to defeat Ozawa in the leadership race.

Ozawa stepped down as party leader last year over a political funding scandal and resigned as the party's No.2 in June.

(Writing by Linda Sieg; additional reporting by Kiyoshi Takenaka and Yoko Nishikawa; Editing by Chris Gallagher)

Japan